Target date mutual funds are designed to manage risk based on the age at which an investor plans to retire, typically in five-year increments (2025, 2030, etc.). Their use has grown rapidly over the last decade, in part because they became the default investment choice for many retirement plans. This shift was meant to keep participants from sitting in cash and missing out on potential returns. While the idea makes sense, target date funds have quirks worth understanding, especially for those approaching retirement.
A Moving Target
If you have the option to own these funds in your 401(k), here are some things you should know (using the Vanguard Target Date 2025 fund as an example*).
What’s Inside a Target Date Fund?
They are designed as a “fund of funds”. The Vanguard 2025 fund, for instance, has five different funds inside of it, each representing part of the stock or bond market. Looking inside each fund within the 2025 target date portfolio is important, as there are many factors to consider when evaluating both stocks and bonds.
Bonds, for example, can behave very differently depending on whether the Fed is raising or cutting interest rates, as well as the maturity of the bonds and their credit ratings.
Performance Comparisons Can Be Misleading
Because they are made up of different assets, target date funds should not be compared to an all-stock index like the S&P 500. The 2025 fund owns 40% bond funds and 21% international stocks, which have outperformed the S&P 500 by a wide margin so far in 2025.
Instead, 2025 funds should be compared to similar funds based on cost, holdings, and long-term strategy.
Risks May Be Greater Than You Think
Retirement is not a finish line. For many, it can last decades. Target date funds account for this by keeping a meaningful allocation to stocks, even as retirement approaches. Still, this is the stage where it becomes critical to understand what kinds of stocks and bonds you actually own. Diversification can help you manage volatility, and with bonds offering 5–6% yields today, it’s worth asking: Do you really need 60% of your portfolio in equities?
A Good Accumulation Tool, But a Blunt Planning Instrument
For people with an extended retirement horizon, target date funds can be a straightforward way to gain broad market exposure. As retirement draws closer, though, investments often need to be more tailored than target funds allow. Two people retiring in the same year may have very different risk profiles and income needs, and a single fund can’t reflect those differences.
Target date funds can also limit flexibility. For example, it’s difficult to rebalance or use tax-loss harvesting inside a target date fund, since you would need to sell the entire fund to do so. With individual investments, you can sell one position, realize the loss, and reinvest in a comparable fund. This way, you remain invested and still capture the loss to offset future gains.
Final Takeaway
Target date funds have an improved investor experience in retirement plans, but they run the risk of breeding complacency as retirement approaches.
As with any investment, it is important to know both what you own and why you own it. A financial plan should help determine how much income and growth is needed in retirement. With that knowledge, you can decide when a target date fund is still the right fit and when it may be time for a more customized approach.
*Source: YCharts. Before investing, consider the funds’ investment objectives, risks, charges, and expenses. Contact Vanguard for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.
This information is intended to be educational and is not tailored to the investment needs of any specific investor. Investments in target date retirement funds are subject to the risks of their underlying funds. The investment risk of each target date fund changes over time as its asset allocation changes. That is, the fund will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. An investment in a Target Retirement Fund is not guaranteed at any time, including on or after the target date. These risks are subject to the asset allocation decisions of the Investment Adviser. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. These fund suggestions are based on an estimated retirement age of approximately 65. Should you choose to retire significantly earlier or later, you may want to consider a fund with an asset allocation more appropriate to your particular situation. All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. Investments in bonds are subject to interest rate, credit, and inflation risk.
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